Russia turns to Arctic offshore oil development

According to data from the Joint Organization Data Initiative, Saudi Arabia has surpassed Russia as the world’s largest oil producer, a position which the latter country held for six years. The Middle Eastern kingdom’s oil production rose to a 31-year high last year, while Russia’s dropped. As Matthew Hulbert writes in his analysis for Forbes, “If we wanted any further evidence why the Arctic really matters for Russia, we just got it.” Declining production in Western Siberia can only be replaced by drilling for offshore oil, in Russia’s Arctic. Whereas Saudi Arabia has spare capacity, allowing it to ramp up production, Russia is already producing to the fullest extent possible.

A drop in production is a scary thing to contemplate for President Vladimir Putin, who began his third presidential term earlier this month. He has succeeded in large part by placating the middle class with economic growth and stability. Since oil and gas compose two-thirds of Russia’s exports, both the price of oil and volume of oil the country exports are crucial to maintaining his power. The price of oil has held steady lately at over $100/barrel. But what has changed in recent years are two things. First, Putin keeps promising more and more, requiring a higher cost per barrel of oil to make ends meet. With increases to pensions and a 33% hike in the defense budget, the Economist reports that the country will need oil to sit at $130 a barrel to balance its budget, which is funded about 60% by oil and gas taxes. Second, the discovery of new sources of oil has slowed down, and offshore oil production will not begin in earnest until 2020. The Kremlin reports that Russian oil production has has remained near the highs reached after the fall of the USSR, but latest figures show that not only has production slowed, it has actually decreased.

As you can see from the chart above, the difference between Saudi and Russian oil production is minimal. However, the recent drop in Russian oil production is quite large, at 5% between December 2011 and January 2012 – a decline of 500,000 barrels, which Mark Adomanis of Forbes says is “the equivalent of the total production of a country like Argentina or Ecuador disappearing overnight.” He questions whether the data is accurate, since there were no reports of problems within the Russian oil industry that would cause such a dramatic drop.

Regardless of whether production has fallen off that much and that quickly, Putin knows that new sources of oil need to be exploited. He has announced that exports from new offshore fields will enjoy business-friendly tax rules for at least the next fifteen years, and he is even considering allowing private companies to receive licenses to drill. This would be a big change for a country in which the oil and gas industries are controlled by state-owned companies Rosneft and Gazprom. The new tax rules, which will tax exports less the more difficult the oil is to extract, are designed to foster $500 million in investment in offshore oil. Production will be ranked according to four different categories, with the most challenging areas being the Laptev Sea, East Siberia, Bering Sea, the northern part of the Kara Sea, and the Sea of ​​Okhotsk, and the second most difficult areas in parts of the Arctic such as the Barents Sea, Pechora, and the southern part of the Kara and Okhotsk seas, including the continental shelf of Sakhalin.

In recent weeks, Rosneft has announced that it will team with Exxon Mobil in the Kara Sea and the Italian oil company Eni in the Barents Sea. Tax breaks will also probably encourage Statoil and Total to resuscitate the Shtokman natural gas project, in which they have stakes. It had been put on hold due to uncertainty with regard to tax regulations. All of this could bode well for Russian offshore oil and gas production, but if the government lowers taxes, the country’s budget will not get as big a boost as it otherwise would have from such development. Putin will have to strike a balance between inviting investors to help exploit resources on the continental shelf, which Russia does not have the know-how to do alone, and balancing the budget.